Robert Prechter of Elliott Wave International and the leading proponent of Socionomics (social mood determines events, rather than the other way around) has been, in my mind, one of the only analysts/pundits/economists out there who has legitimately called both the deflationary credit crisis and the ensuing rally that we are in now. His unique method tracks the stock market as a barometer of social mood which patterns itself in distinct formations representing fear and greed. Very few others are willing to subscribe to his theories and quite understandably so. They imply that human nature leaves us with very little to determine on our own. More accurately: the character of society and the economy are preordained, but the exact events that result are not.
Similar parallels can be drawn with generational theories put forward by Neil Howe and William Strauss and continued by John Xenakis. These suggest that generational archetypal characteristics are defined and develop based on the environment they have been raised in, which itself moves in predictable cycles making future socioeconomic shifts an inevitability.
The two separate theories are not entirely compatible, but they share more similarities than they do differences, the primary one being that there is very little any person, leader or government can do to alter the broad course of the future. Both theories can say, for example, that society in general is more likely to embrace a fanatical leader at certain times than others; that society in general is more likely to reject international cooperation, free trade, high taxes, social programs, etc at certain points in their cycles; that women in general will be more inclined to dress and act conservatively, bear children, etc after experiencing certain types of events earlier in their lives. Neither theory can say, however, what they will wear, or what level of taxation will be acceptable, or what kind of fanatical leader will be embraced.
I subscribe to both of these theories because they appear to have a far better record in predicting broad changes in the economy, and therefore make investing decisions much easier. I admit that they are disturbing in a way. As a person who has studied economics at a theoretical level, and believe that certain policies and social structures will prove to be more beneficial than others, it is difficult to reconcile that no matter what path we choose to take, there will always be social and economic cycles and the undesirable consequences inherent in them. Then again, I remember a wise man advising that the ability to hold two opposing views simultaneously is somehow virtuous. But I digress...
The reason I believe that Prechter has been nailing the tops and bottoms of the last few years is because of his contrary position as to the causal nature of social and economic events. That's not to say he can't be wrong. He has, in fact, been very wrong in the past, thinking that the '87 crash was going to mark the same kind of top he thinks we have made in '07. But to me, an extra 20 years of experience and time to further develop his method makes his opinion more worth listening to, not less. He does not seem to make media appearances discussing his directional calls unless the wave pattern is very compelling.
This week he made an appearance on Yahoo's Tech Ticker. The four short videos can be found below in no particular order (thanks to reader Mike for the heads up):
Prechter does hedge with the "corrective waves are complex" line, so I would be cautious to start shorting anything very aggressively. The markets seem to be hitting their maximum upside targets before retracing to their minimum targets, which is still a sign of strength and deserving of respect. Bob mentions extremely positive sentiment on equities (93% bulls) which, of course, could turn into 95% or 98% just as easily with another final rally toward S&P 1100/Dow 10000.
Prechter would say that the purpose of this rally is to "convince as many people as possible that the worst is over." John Xenakis has something he calls "The Principle of Maximum Ruin," where the most people possible are made to suffer the greatest losses possible. And as a trader/investor, I am most definitely familiar with "The Path of Maximum Frustration," where markets will tend to go just far enough to convince you that you've erred before turning around.
We saw this kind of activity from 2005-2007, when real estate had already rolled over, subprime mortgages were blowing up and debts were mounting even higher. All the while the market continued to march higher and all everybody cared about was the next big merger, or how many decades the cinderella economy/great moderation would last. In August of 2007, everything the bears had been talking about for decades started to matter and the markets dropped - only to frustrate as many of them (myself included) to the furthest extent possibe by rallying to new highs 3 months later.
We also saw the same type of activity in late 2008. With the market dropping more than 50% and then rebounding over 27%, the bulls were celebrating a successful recovery and analogies to 1987 were flying all over the place. Months later, the markets collapsed again, methodically eliminating any bullish sentiment before embarking on the largest rally over a 5 month period in 8 decades. The same pattern is at work. But there are limited ways to gauge the extent without the benefit of hindsight.
Because I do believe in the "corrective" nature of this rally, it has always been a very risky proposition for me to justify much long side exposure. It is difficult to see it continue higher without participating much. I bought some November calls in AIG a few weeks ago which appears to be working (that can change fast with such volatility), and I am still holding my LEAP puts on the S&P. Mastering the emotions of such volatile times is no easy proposition, which is why I think both Socionomic and Generational patterns are more important than ever. They seem to provide the only believable explanation of such volatility and are, in my opinion, very likely to be proven correct over the coming years.
I don't often "do" advice in this space, but I think caution is the best course at this time. Pressing short side bets could prove disastrous if done too soon. And chasing the long side can eat into precious capital when inevitably done right at the top.
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